Teaching Notes for Chapter 3
Analysis of Cost, Volume, and Pricing to Increase Profitability
Most students grasp the concepts in this chapter easily. The chapter focuses on
applications that help students refine their understanding of cost behavior. Chapter 2
addressed the more complex task of establishing the conceptual foundation that underlies
cost behavior classifications. A student with a good understanding of basic algebra and
Chapter 2 can readily digest the Chapter 3 material. You can likely cover the material
adequately in approximately two hours. In most cases, students have the foundation to
begin the first class on Chapter 3 with a problem-based learning exercise.
Detailed Outline of a Lesson Plan for Chapter 3
I. Use Demonstration Problem 3-1 as a problem-based learning exercise.
Before providing any instruction on Chapter 3, distribute Demonstration Problem
3-1 and ask students to complete requirement a.
II. After giving students a few minutes to digest the problem and formulate
solutions, engage them in a collaborative learning experience. Ask the
members of each group to reach consensus on the solution to requirement a. If
you have not formed groups, organize students into pairs and have them reach
consensus with their partners.
III. Introduce different methods for analyzing cost-volume-profit relationships.
Use the solution for requirement a of Demonstration Problem 3-1. Students will
likely have used different mathematical approaches to answer the problem-based
learning question. The stage is set to introduce the three methods used to analyze
cost-volume-profit relationships: contribution margin per unit; contribution
margin ratio; and equation. Each method yields the same results.
Begin by pointing out that students probably used a diversity of approaches to
find the answer. Explain that using standardized approaches to compute the
break-even point facilitates communication. First explain the contribution margin
per unit approach.
Contribution Margin Per Unit Approach:
(a) Determine the amount of the contribution margin per unit.
(b) Explain that when the total contribution margin is sufficient to pay for
the fixed cost, Mr. Jamail will break even. Show the computation of
break-even in units.
(c) Show how to compute the break-even point in number of dollars
using the break-even point in units.
(d) Confirm the results by preparing an income statement.
3-1
Contribution Margin Ratio Approach.
(a) Calculate the contribution margin ratio.
(b) Use the ratio to calculate the break-even point in sales dollars, and
then use the selling price to calculate the break-even point in units.
Equation Approach.
(a) Calculate the break-even point in units.
(b) Calculate the break-even point in sales dollars.
IV. Show students how to determine the sales volume necessary to earn a desired
profit. We limit confusion by focusing only on the contribution margin per unit
approach. You can expand the problem by also computing the answers using the
contribution margin ratio approach and the equation method, if you wish.
Begin by referring to requirement b of Demonstration Problem 3-1. Explain that
to earn a desired profit, Mr. Jamail must sell enough cookware sets so that the
contribution margin will be sufficient to pay for fixed costs plus the desired profit.
The computation is:
(Fixed Cost + Target Profit)/Contribution Margin Per Unit = Required Sales in Units
(1)
(2)
(3)
Show the computation that satisfies requirement b1 of Demonstration
Problem 3-1.
Show the computation that satisfies requirement b2 of Demonstration
Problem 3-1.
Confirm the answers to (1) and (2) by showing a contribution margin
format income statement as specified by requirement b3.
IV. Show students how to draw a break-even graph. Complete requirement c of
Demonstration Problem 3-1.
V. Explain margin of safety, and show students how to calculate the margin of
safety in number of sales dollars and as a percentage. Complete requirement
d of Demonstration Problem 3-1.
1. Margin of Safety in $ = Budgeted Sales $  Break-Even Sales $
2. Margin of Safety as a % = (Budgeted Sales  Break-Even Sales) / Budgeted Sales
VI. Introduce target costing by showing students how to establish a target cost
that will provide a desired profit. Complete requirement e of Demonstration
Problem 3-1.
VII. Because Demonstration Problem 3-1 is a comprehensive problem that
includes all of the critical topics in Chapter 3, we have not provided additional
demonstration problems for this chapter. E3-1A through E3-4A, E3-10A, and
E3-12A may be used for additional practice in class or assigned as homework.
3-2
Summary Outline of a Lesson Plan for Chapter 3
I. Use requirement a of Demonstration Problem 3-1 as a problem-based
learning exercise.
II. After giving students a few minutes to digest the problem and formulate
solutions, engage them in a collaborative learning experience.
III. Introduce different methods for analyzing cost-volume-profit relationships.
Use requirement a to demonstrate that each method yields the same results.
Contribution Margin Per Unit Approach.
Contribution Margin Ratio Approach.
Equation Approach.
IV. Show students how to determine the sales volume necessary to earn a desired
profit. Focus only on the contribution margin per unit method.
(Fixed Cost + Target Profit)/Contribution Margin Per Unit = Required Sales in Units
(1)
Show the computation that satisfies requirement b1 of Demonstration
Problem 3-1.
(2)
Show the computation that satisfies requirement b2 of Demonstration
Problem 3-1.
(3)
Confirm the answers to (1) and (2) by showing a contribution margin
income statement as specified by requirement b3.
IV. Show students how to draw a break-even graph. Complete requirement c of
Demonstration Problem 3-1.
V. Show students how to calculate the margin of safety in number of sales
dollars and as a percentage. Complete requirement d of Demonstration
Problem 3-1.
VI. Introduce target costing by showing students how to establish a target cost
that will provide a desired profit. Complete requirement e of Demonstration
Problem 3-1.
VII. E3-1A through E3-4A, E3-10A, and E3-12A may be used for additional
practice in class or assigned as homework.
3-3
Quiz Questions for Chapter 3
Use the following information for Boxware Corporation to answer the next four
questions:
Sales price per unit
$190
Variable cost per unit
$ 80
Average production
1,500 units per month
Total fixed costs
$55,000 per month
1.
What is Boxware's contribution margin per unit?
a. $ 80
b. $110
c. $190
d. $270
2.
How many units per month must Boxware sell each month to break even?
a. 500
b. 1000
c. 1500
d. 2000
3.
What amount of sales volume in dollars must Boxware achieve each month in order
to break even?
a. $95,000
b. $190,000
c. $285,000
d. $76,000
4.
How many units per month must Boxware sell in order to make a $110,000 profit?
a. 500
b. 1,000
c. 1,500
d. 2,000
Use the following information to answer the next three questions: Derek's Drum
Depot (DDD) wants to add a new line of drumsticks to its product line. The following
data apply to the new drumsticks line.
Budgeted sales
30,000 sets per year
Sales price
$5
per set
Variable costs
$3
per set
Fixed costs
$10,000 per year
5.
The break-even point for the new line is _______ sets per year.
a. 500 sets
b. $5,000
c. 15,000 sets
d. 5,000 sets
3-4
6.
The margin of safety for DDD is
a. 83%
b. 15,000 sets
c. 19%
d. 6,000 sets
7.
How many sets of drumsticks must DDD sell to make a profit of $50,000 on the
new line?
a. 2,000 units
b. 10,000 units
c. 20,000 units
d. 30,000 units
Use the following data for Firewall Software Corporation to answer the next three
questions:
Sales price per unit
$44.95
Variable manufacturing cost per unit
$17.03
Variable sales commissions per unit
$ 3.20
Variable shipping expense per unit
$ 1.14
Fixed administrative cost, per month
$12,200
Other fixed costs, per month
$2,269
Average production
2,100 units per month
8.
What is the amount of contribution margin per unit, based on this information?
a. $21.37
b. $23.58
c. $27.92
d. $24.72
9.
How many units must Firewall sell in order to break even? (round to the nearest
whole unit)
a. 308
b. 500
c. 614
d. 620
10. How many units must Firewall sell in order to make a $50,000 profit? (Round to the
nearest whole unit.)
a.
505
b. 1,090
c. 1,708
d. 2,734
3-5
Solutions to Quiz Questions
Question
Answer
1
2
3
4
5
6
7
8
9
10
B
A
A
C
D
A
D
B
C
D
3-6
Demonstration Problem for Chapter 3
Demonstration Problem 3-1 Cost-Volume-Profit Analysis
Jeff Jamail is evaluating a business opportunity to sell cookware at trade shows. Mr. Jamail can buy the
cookware at a wholesale cost of $210 per set. He plans to sell the cookware for $350 per set. He
estimates fixed costs such as plane fare, booth rental cost, and lodging to be $5,600 per trade show.
Required
a. Determine the number of cookware sets Mr. Jamail must sell at a trade show to
break even (zero profit or loss).
b.
Assume Mr. Jamail wants to earn a profit of $4,900 per show.
(1) Determine the sales volume in units necessary to earn the desired profit.
(2) Determine the sales volume in dollars necessary to earn the desired profit.
(3) Using the contribution margin format, prepare an income statement to confirm
your answers to parts 1 and 2.
c.
Draw a break-even graph.
d.
Determine the margin of safety between the sales volume at the break-even point
and the sales volume required to earn the desired profit. Determine the margin of
safety in both sales dollars and as a percentage.
e.
After researching the market, Mr. Jamail concludes that the $350 per set selling price
is too high. Customers will likely pay only $310 per set. Mr. Jamail believes he can
obtain a cost reduction from his supplier of $20 per set (variable cost drops from
$210 per set to $190 per set) and still provide the level of quality required to achieve
a sales volume of 75 sets. Under these circumstances, what amount of fixed costs
can Mr. Jamail incur and still obtain the target profit of $4,900? Support your
answer with appropriate computations.
3-7
Demonstration Problem 3-1 Solution
a. Break-even point
(1)
Contribution Margin Per Unit Approach
(a)
Determine the contribution margin per unit.
Per Unit Contribution Margin
Sales Price
Variable Cost
Contribution Margin
(b)
$350
210
$140
When the total contribution margin is sufficient to pay for
the fixed costs, Mr. Jamail will break even. The number of
units required to break even can be computed as follows:
Formula for Computation of Break-Even Point in Units
Fixed Cost
$5,600
 = 
Contribution Margin Per Unit
$140
(c)
40 sets
The break-even point in number of dollars can be
computed as follows:
Break-Even Point in Sales Dollars
Sales Price Per Unit
Times Number of Units
Sales Volume in Dollars
(d)
=
$
350
40
$14,000
Confirm the results by preparing an income statement.
Income Statement
Sales (40 x $350)
Variable Cost (40 x $210)
Contribution Margin
Fixed Cost
Net Income
3-8
$14,000
(8,400)
5,600
(5,600)
$
0
(2)
Contribution Margin Ratio Approach
(a)
The contribution margin ratio is computed as follows.
Contribution Margin Ratio
Contribution
Margin
Ratio
(b)
Contribution Margin Per Unit
=
$140
=
Sales Price Per Unit
= .4
$350
Using the contribution margin ratio, calculate the breakeven point in sales dollars and units.
Break-Even Point in Sales Dollars
Break-Even
Fixed Cost
$5,600
in Sales
=
=
= $14,000
Dollars
Contribution Margin Ratio
.4
Break-Even Point in Number of Units
Break-Even
in Units
=
Total Sales
=
Sales Price Per Unit
(3)
$14,000
= 40 Units
$350
Equation Approach
(a) Use the break-even equation and solve for number of units:
Break-Even Equation
Sales Price x Units = Variable Cost x Units + Fixed Cost
$350 x Units = $210 x Units + $5,600
$140 x Units = $5,600
Units = 40 sets
3-9
(b)
Compute the break-even point in dollars as in part a3
above:
Break-Even Point in Sales Dollars
Sales Price
Times Number of Units
Sales Volume in Dollars
b.
(1)
$
350
40
$14,000
Target profit
Sales Volume Required to Earn a Desired Profit
Formula for Computation of Sales Volume Necessary to Earn
a Target Profit of $4,900
Fixed Cost + Target Profit
$5,600 + $4,900
 =  = 75 sets
Contribution Margin Per Unit
$140
(2)
Determine the sales volume in dollars required to earn the
desired profit.
Required Sales in Number of Dollars
Sales Price
Times Number of Units
Sales Volume in Dollars
(3)
$
350
75
$26,250
Confirm the answers by preparing an income statement.
Income Statement
Sales
Variable Cost (75 x $210)
Contribution Margin
Fixed Cost
Net Income
3-10
$26,250
(15,750)
10,500
(5,600)
$ 4,900
c. Break-Even Graph
$25,000
Break-even
Point
$20,000
$14,000
Break-Even
Point in $
Area of
Profitability
y
$15,000
Total Sales
Total Cost =
Variable Cost +
Fixed Cost
$10,000
Fixed Cost
$5,600
$ 5,000
Area of
Loss
-0-0-
10
20
Unit
s
40 Break-Even Point in Units
30
40
50
d. Margin of Safety
(1)
Margin of Safety Expressed in Sales Dollars:
Margin of Safety
Budgeted Sales to Earn Target Profit (75 sets x $350) $26,250
Break-even Sales (40 sets x $350)
14,000
Margin of Safety
$12,250
(2)
Margin of Safety Expressed as a Percentage:
Margin of Safety Percentage
Margin of Safety in $

Budgeted Sales
=
3-11
$12,250

$26,250
=
46.7%
e. Target Costing
Use the Break-Even Equation and Solve for Fixed Cost:
Equation Approach to Compute Fixed Cost
Sales Price x Units = Fixed Cost + (Variable Cost Per Unit x
Units) + Profit
Sales Price x Units  [(Variable Cost Per Unit x Units)]  Profit =
Fixed Cost
($310 x 75 Units)  [($190 x 75 Units)]  $4,900 = Fixed Cost
$23,250  $14,250  $4,900 = Fixed Cost
$4,100 = Fixed Cost
Confirm the
statement.
computations
by
preparing
an
income
Income Statement
Sales (75 x $310)
Variable Cost (75 x $190)
Contribution Margin
Fixed Cost
Net Income
3-12
$23,250
(14,250)
9,000
(4,100)
$ 4,900
Demonstration Problem 3-1 Work Papers
a.
Break-even point
(1) Contribution Margin Per Unit Approach
(a)
Determine the contribution margin per unit.
Per Unit Contribution Margin
Sales Price
$
$
(b)
When the total contribution margin is sufficient to pay for
the fixed costs, Mr. Jamail will break even. The number of
units required to break even can be computed as follows:
Formula for Computation of Break-Even Point in Units

(c)
$
= 
$
=
The break-even point in number of dollars can be
computed as follows:
Break-Even Point in Sales Dollars
Sales Price Per Unit
$
$
(d)
Confirm the results by preparing an income statement.
Income Statement
Sales
Net Income
3-13
$
(
)
(
$
)
0
(2)
Contribution Margin Ratio Approach
(a)
The contribution margin ratio is computed as follows.
Contribution Margin Ratio
Contribution
Margin
Ratio
(b)
$
=
=
=
$
Using the contribution margin ratio, calculate the breakeven point in sales dollars and units.
Break-Even Point in Sales Dollars
Break-Even
in Sales
=
Dollars
$
=
=$
Break-Even Point in Number of Units
Break-Even
in Units
=
$
=
=
$
(3)
Equation Approach
(a) Use the break-even equation and solve for number of units:
Break-Even Equation
3-14
(b)
Compute the break-even point in dollars as in part a3
above:
Break-Even Point in Sales Dollars
Sales Price
$
$
b.
(1)
Target profit
Sales Volume Required to Earn a Desired Profit
Formula for Computation of Sales Volume Necessary to Earn
a Target Profit of $4,900

(2)
=  =
Determine the sales volume in dollars required to earn the
desired profit.
Required Sales in Number of Dollars
Sales Price
$
$
(3)
Confirm the answers by preparing an income statement.
Income Statement
Sales
$
(
(
$
Net Income
3-15
)
)
c. Break-even graph
$25,000
$20,000
$15,000
$10,000
$ 5,000
-0-0-
10
20
30
40
50
Unit
s
d. Margin of safety
(1)
Margin of Safety Expressed in Sales Dollars:
Margin of Safety
$
$12,250
(2)
Margin of Safety Expressed as a Percentage:
Margin of Safety Percentage

=
3-16
$

$
=
e. Target Costing
Use the Break-Even Equation and Solve for Fixed Cost:
Equation Approach to Compute Fixed Cost
Confirm the
statement.
computations
by
preparing
an
income
Income Statement
Sales
$
(
(
Net Income
3-17
)
)
$ 4,900